Intel's Mobile Losses Are a Necessary Evil

Intel's (NASDAQ: INTC  ) Mobile and Communications Group lost approximately $3.2 billion during its fiscal 2013. There's no sugar-coating the fact that these losses are substantial.

But while these losses have been a significant drag on Intel's bottom line, it is important to understand why the company's management team is making the strategic decision to incur these very heavy losses. The plain and simple fact is that it costs a lot to develop the technologies required to be competitive in mobile.

It costs serious cash to play in Qualcomm's arena
Over the years, wireless chip powerhouse Qualcomm (NASDAQ: QCOM  ) has developed leadership IP in graphics, modems, RF front end, memory controllers, system-on-chip fabric, CPU cores, and more. Not surprisingly, Qualcomm is far-and-away the market share leader in mobile processors. 

Given that Qualcomm spends north of $3 billion per year on mobile/wireless chip-related R&D, a competitor would need to spend at least as much just to try to gain an even technological footing. In the process, such a challenger would need to incur severe losses before the product pipeline has a shot of generating revenue. 

That's what Intel is doing
While some will claim that Intel's "contra-revenue" scheme to offset a bill of materials deficiency is what drives the company's massive mobile losses, this simply doesn't make sense. Intel barely shipped 10 million tablet chips in 2013 (and to investors' knowledge, these did not require contra-revenue support), and the division still lost $3.2 billion.

The loss, of course, will get worse in 2014 as Intel provides contra-revenue support likely in the range of $10-$20 for each of its tablet chips shipped this year (and there will be 40 million of them). As you can clearly see, though, the contra-revenue hardly constitutes the bulk of the operating loss (and this is a temporary measure that should be largely eliminated by 2015).

The losses don't go away until the revenue comes in
In order for that greater-than-$3 billion loss to go away, Intel will need to drive pretty significant revenue growth in its Mobile and Communications business. Depending on your assumptions, this business requires about $7-$8 billion in sales to reach breakeven.

Today, Intel's Mobile and Communications Group consists of discrete 2G/3G and now 4G modems. Going forward, Intel will need to participate heavily in the mobile applications processor space (tablets and phones) if it is to generate enough revenue to bring that division to breakeven.

Can't Intel just ditch mobile?
While the obvious solution to this problem would be to "ditch mobile," the not so obvious answer is that this would be a long-term strategic error for the company. Intel is fundamentally a computing company, and for the company to simply refuse to participate in the smartphone/tablet apps processor market (in aggregate worth over $20 billion today and growing) would be unwise. Intel should and will leverage its massive PC and server success today to fund its long-term future. 

Foolish bottom line
Breaking into new industries and trying to take share against an established incumbent is very difficult. Qualcomm is an exceptional company and its moat in wireless chips is very wide and deep. Intel is one of the few companies with the sheer financial and technical might to have even a prayer of competing profitably with Qualcomm in the long run, and it should attempt to do so while it is still massively profitable and can afford to do so. 

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